2 What is short-term credit? What are the major sources? 17-7 Short-term credit: Debt requiring repayment within one year. Major sources: Accruals Accounts payable (trade credit) Commercial paper Bank loans 17-8 Short-term debt is riskier than long-term debt for the borrower. Short-term rates may rise. May have trouble rolling debt over. Advantages of short-term debt. Typically lower cost. Can get funds relatively quickly with low transactions costs. Can repay without penalty Is there a cost to accruals? Do firms have much control over amount of accruals? Accruals are free in the sense that no explicit interest is charged. However, firms have little control over accrual levels, which are influenced more by industry custom, economic factors, and tax laws than by managerial actions. What is trade credit? Trade credit is credit furnished by a firm s suppliers. Trade credit is often the largest source of short-term credit for small firms. Trade credit is spontaneous and relatively easy to get, but the cost can be high JAWS buys $3,030,303 gross, or $3,000,000 net, on terms of 1/10, net 30. However, the firm pays on Day 40. How much free and costly trade credit are they getting? What is the cost of the costly trade credit? Gross/Net Breakdown Company buys goods worth $3,000,000. That s the cash price. They must pay $30,303 more over the year if they forego the discount. Think of the extra $30,303 as a financing cost similar to the interest on a loan. Must compare that cost with the cost of alternative credit.

6 What is a secured loan? In a secured loan, the borrower pledges assets as collateral for the loan. For short-term loans, the most commonly pledged assets are receivables and inventories. Securities are great collateral, but generally firms needing short-term loans generally do not have securities. Chapter 17 Extension: Secured Short-Term Financing Accounts receivable financing Inventory financing Important Legal Forms Security Agreement: Standard form under the Uniform Commercial Code. Specifies when lender can claim collateral if default occurs. UCC Form-1: Filed with Secretary of State to establish collateral claim. Prospective lenders will do a claims search, and won t make the loan if a prior UCC-1 has been filed What is the difference between pledging and factoring receivables? If receivables are pledged, the lender has recourse against both the original buyer of the goods and the borrower. When receivables are factored, they are generally sold, and the buyer (lender) has no recourse to the borrower. What are three forms of inventory financing? Blanket lien. Trust receipt. Warehouse receipt. The form used depends on the type of inventory and situation at hand.

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